Boots in play

Bitter pill

The chemist is the healthiest it has been in years. Why change the prescription?

BRITAIN may have moved on a little since Napoleon's day, but for private-equity investors it remains a nation of shopkeepers. Five weeks after news broke of a bid for J. Sainsbury (a supermarket chain), Kohlberg Kravis Roberts (KKR), an American private-equity firm, announced a £9.7 billion offer for Alliance Boots, Britain's largest chain of chemists, on March 9th. If the deal goes through, it will be the largest of its kind so far in Europe.

Even in a country that prides itself on its open economy, nerves get a little frayed when outfits such as KKR (which was also involved in the bid for Sainsbury's) gather at the checkout tills. In the past four years Marks & Spencer, WH Smith, Debenhams and HMV have all either flirted or tussled with buy-out firms. Suspicion lingers that private-equity firms are just asset-strippers in pin-striped suits. Yet if Boots indeed vanishes from public view, critics of private equity may struggle to make that case.

Unlike Sainsbury's, which owns more than £7.5 billion-worth of land that could easily be sold and leased back, Boots already leases most of its stores. John Ralfe, in a note for RBC Capital Markets, an investment bank, thinks the owned shops that remain would fetch just £1.5 billion. And although the firm's balance sheet shows debt at a relatively light £1.1 billion, Mr Ralfe reckons its lease commitments add the equivalent of another £1.5 billion to its debt. So relying on financial engineering alone to produce big profits for new owners looks risky.

Nor, like WH Smith or Marks & Spencer when they were pursued, is Boots in especial need of new managers to give it a sharp kicking in private. That might have been useful a few years ago, after an ill-advised expansion had combined car parts and children's clothes with laser eye surgery, botox and dentistry.

But Richard Baker, its chief executive, has sold many of its esoteric operations. By sprucing up the company's tatty stores a bit, he has managed to increase its share of the market for health and beauty products, despite competition from supermarkets. And he has exploited a trusted brand to strengthen Boots's grip on filling prescriptions, a task few Britons entrust to supermarkets. The wholesale drugs-distribution business has also been expanded through a £7 billion merger with Alliance Unichem, a chain of pharmacies.

The bid, if successful, would simply recycle many of the existing top team, not least Stefano Pessina, the chemist's executive deputy chairman (and biggest shareholder), who has teamed up with KKR. People close to the talks say that Mr Pessina, who built up Alliance Unichem before pushing it into a “merger of equals” with Boots, thinks that the demands of quarterly reporting make it too hard for the firm to restructure in a way that might dampen earnings in the short term but improve long-term profitability.

He has a point. Analysts at Sanford Bernstein, for instance, raised their valuation of Boots from £8.95 a share before the bid to £10.60 after it, in part because they felt able to include estimates of future earnings that they had excluded before.

Institutional shareholders now worry that perhaps they have been too mean in assessing Boots's prospects, given that Mr Pessina thinks it such a bargain even after the 16% rise in its shares in the past year. Yet he too has cause for reflection. Part of his well-paid job was to explain its strategy to the market, and his bid is an admission that he did it poorly. If the deal goes ahead, he stands to benefit handsomely nonetheless. If it fails, Boots is likely to be looking for a new deputy chairman.